Low mortgage rates unleashed a massive wave of refinancing that was a windfall for millions of consumers, but what will happen once those unusually low mortgage rates are gone? Will refinancing mortgage loans effectively be sidelined as a financial resource for home owners?
While the opportunity to lower your interest rate may be the most compelling reason to refinance, it is just one of several. Refinancing can accomplish different things for different people, and the more you are aware of what refinancing can do, the more likely you are to be able to use it to your advantage.
5 compelling reasons to refinance your mortgage
Here are five good reasons to refinance:
1. Reduce interest rates
A drop in market rates can create a compelling opportunity to refinance. However, even if interest rates generally are not lower than those on your current mortgage, you still may be able to lower your rate by refinancing. Rates on shorter mortgages and on adjustable rate mortgages are generally much lower than those on 30-year mortgages.
So, if you can afford the higher payments that come with a shorter mortgage, you might be able to lower your interest rate by refinancing from a 30-year to a 15-year loan. As for adjustable rate mortgages, the drawback with them is that the rate is subject to vary, so you won't necessarily be lowering your interest rate for the life of the loan.
However, if you only anticipate being in your current home for a few years more, you might be able to benefit from an adjustable rate mortgage without the long-term risk of rate fluctuations.
2. Lower long-term interest expenses
Shorter mortgages don't just carry lower rates. They also mean paying interest for fewer years. Even if conditions are such that you can't lower your mortgage rate, you might find you could achieve significant long-term savings by switching to a shorter mortgage.
3. Eliminate mortgage insurance premiums
Mortgages like loans from the U.S. Federal Housing Administration that allow low down payments also typically require that you pay for mortgage insurance. Once you have built more equity in your home though, you might qualify for a type of loan that does not require mortgage insurance, so that could represent a potential savings if you refinance.
4. Make monthly payments more affordable
Stretching your remaining payments out over a longer period can result in reducing those payments. Lengthening your loan is also likely to result in paying more total interest in the long run. But if it is the only way to make your mortgage affordable, this can be a good reason to refinance.
5. Switch from an adjustable rate to a fixed-rate loan
You may have chosen an adjustable rate mortgage for a variety of reasons, but if you plan on being in your home for the long-term it would reduce your financial risk to stabilize your monthly mortgage payments. You could do this by switching from an adjustable rate to a fixed-rate loan.
What you need to refinance
To take advantage of your refinancing opportunities, it helps to have the following:
1. Equity – and the more the better
While government programs temporarily made refinancing available to some home owners with little or no equity in their homes (due to the collapse in home prices following the housing crisis), generally you are going to need a solid amount of equity in your home in order to qualify for refinancing. If you have 20 percent or more, you may be able to qualify for a loan that does not require you to pay mortgage insurance.
2. A good credit score
Keeping your credit healthy means keeping your refinancing options open – and you never know when the right conditions might arise.
3. Steady employment
If you are thinking of refinancing, you might want to do it before you make a change in jobs. Lenders like applicants who have held their jobs for a long time.
4. Closing costs
Closing costs will probably total at least a couple thousand dollars, and very often much more than that. You can finance this, such as by adding the closing costs to the amount you are borrowing in the new mortgage. But this will be more expensive in the long run and could eat into your equity balance. As noted previously, less equity (or what's known as a higher loan-to-value ratio) can negatively impact your ability to qualify for refinancing. Or it could result in you paying more in mortgage insurance premiums.
Consider a low interest rate environment as the low-hanging fruit among refinancing scenarios. However, it is not the only worthwhile reason to refinance. Getting the most out of the potential benefits that refinancing presents requires knowing the different things it can accomplish, and being prepared to act on your refinancing opportunities.
Richard Barrington, CFA, is a 20-year veteran of the financial industry, including having served for over a dozen years as a member of the Executive Committee of Manning & Napier Advisors, Inc.